Click here to read the Too Much weekly edition, as emailed to readers on January 11, 2010.

This Week in Too Much

Next Monday, January 18, Goldman Sachs will reportedly release the figures on the bank’s bonus outlays for 2009. That should make next Monday one of the most fascinating — and infuriating — days in U.S. financial history.

A bank that nearly crashed 16 months ago — and avoided crashing only because the federal government came galloping to the rescue — will hand out over $20 billion in bonuses at a time when one out of every ten Americans can’t find work.

Is this just greed, or something worse? Like insanity. The power suits at Goldman Sachs, former International Monetary Fund chief economist Simon Johnson noted last week, “really think they are worth the money.”

We really think our nation’s top leaders, from the White House on down, desperately need to get serious about ending, once and for all, the mad grasping at America’s economic summit. We explain why in this week’s Too Much.

Greed at a Glance

What do bankers do with all those bonus dollars that get stuffed into their pockets? The Financial News is pledging this year to help us find out — via an anonymously written fortnightly column by a “a senior investment manager” in London who “believes in living life to the full.” The just-published first installment of this “Fat Cat Diary” takes us to the holiday getaway of Barbados where rooms at the Sandy Lane Hotel cost up to $15,000 a night and “the well-heeled are fast-tracked through passport control” into limos. The island’s biggest attraction? Writes Fat Cat: “People come to be seen and to be safe.”

Heinrich Weber, a 46-year-old private banker with a global super-rich clientele, isn’t writing a public diary this year. But he is spilling the beans about the troubled lives he sees his clients leading. Those born incredibly rich, Weber told Der Spiegel last week, “have seen the dark side of wealth.” Many suffer chronic “emotional problems,” since they mistrust everyone. Many feel inadequate, too, never able to meet the “high expectations they are expected to fulfill.” Casey Johnson, an heir to the Johnson & Johnson fortune, won’t be struggling to meet expectations any more. Johnson, age 30, was found dead in Los Angeles last Monday. The celebrity socialite, in a 2006 Vanity Fair interview, had complained about how tiresome privilege can become. Noted Johnson, who received her first Chanel bag at age 10: “It’s so boring to do nothing. Believe me, I’ve tried it. It’s, like, how many days a week can you actually go shopping? You get burned out.”

Pete Peterson, a retired private equity fund billionaire, has been obsessing about federal budget red ink for years — and he has a solution. Hike tax rates on the rich, back to mid-20th century levels? Of course not. Peterson is pushing instead to cut back on “entitlements,” the dollars spent on Social Security and Medicare, and he’s breaking new plutocratic ground to do that pushing. Peterson has started up his own “news” agency, the Fiscal Times, and staffed it with eight veteran journalists. The Washington Post is already partnering with Peterson’s PR shop to “jointly produce content focusing on the budget and fiscal issues.” That’s “like buying political propaganda from a Washington lobbyist,” notes former Post reporter William Greider, “then printing it in the news columns as if it was just another news story.” The Campaign for America’s Future has launched an effort to press the Post to sever ties with Peterson’s faux news operation . . .

Last Thursday night, before a national TV audience, University of Texas football coach Mack Brown committed a coaching blunder just before half-time that cost his team the national title. But the real blunder that defines Texas football, faculty at the university are charging, came last month when the university’s Board of Regents jacked up Mack Brown’s take-home from $3 million to $5 million a year. A Texas Faculty Council vote has blasted that pay hike as “unseemly and inappropriate.” One reason: The university, off the gridiron, is laying off staff and taking steps to raise tuition. Pay at the top at Texas reflects a much broader trend. In 2006, only one college football coach made at least $3 million. Last year, a dozen coaches made at least that much . . .

If paychecks keep escalating at the top college sports powerhouses, coaches may soon make nearly half as much . . . as artists who sell their wares to the world’s super rich. According to just-released data from Artprice, the art world’s global scorekeeper, 10 artists sold at least $10.6 million worth of artwork in the year that ended last June. Numero uno on the Artprice list: Britain’s Damien Hurst, with a haul worth $215.9 million. Americans ranked two, three, and four in the top ten. Works by Jean-Michel Basquiat, Richard Prince, and Jeff Koons auctioned off for $126.5 million. Meanwhile, in Los Angeles last week, community groups were mobilizing to stop budget cuts slated to eliminate all the city’s elementary school art teachers over the next two years.

Quote of the Week

“Banks are back in the land of bliss, executive salaries have returned to their skyward trajectory, and politicians are running a reform-minimalist agenda.”
John Sutton, national secretary, Australian Construction Forestry Mining and Energy Union, reacting to a new government report that rejects limits on executive pay, January 5, 2010

Stat of the Week

What might be the biggest speeding ticket of all time has just gone to a tycoon caught racing through a small Swiss village — in a red Ferrari Testarossa — at 35 mph over the speed limit. The fine totaled $290,000, over double the previous Swiss record. Swiss courts have been meting out mega fines ever since Swiss voters opted in 2002 to replace jail time for offenses like speeding with fines based on income. The deep pocket in the Testarossa, the BBC reports, owns four other luxury cars besides his Ferrari.

In Focus

When Will the White House Wake Up?

The President has the power to take on the CEO set — and the windfalls that are so enraging average Americans.

A year ago, movers and shakers at the upper echelons of the Democratic Party were celebrating the biggest congressional majorities for Democrats in a generation. Last week, in those same upper echelons, gloom and doom were reigning.

The immediate source of the unease: the surprise announcement that Senator Byron Dorgan from North Dakota, a popular Democrat in a heavily Republican state, would be retiring at year end.

“Substantial” Republican gains in the 2010 congressional elections, pollsters predict, now appear “almost inevitable.” In some polling, the right-wing “Tea Party” movement is posting higher favorable numbers than the Democrats.

That Tea Party movement, notes labor analyst Les Leopold, is expressing “the fury of Americans who have watched the financial elites rip off the economy, then crash it, then cash in on government bailouts, and then commence to rip off the economy all over again.”

Every week’s headlines only seem to feed that fury even more. Last week, for instance, brought the news that Citigroup, the biggest bailed-out bank, handed its investment banking chief, John Havens, a $8.97 million payday on December 30. In all, four other Citi execs walked off with over $8.5 million last year. Citi is still holding 25 billion in U.S. taxpayer dollars.

Or how about H. Edward Hanway, who retired December 31 as CEO of the health insurer giant Cigna? At the start of Hanway’s last year as CEO, Cigna announced plans to ax 1,100 jobs. The company then went on to post a $208 million first-quarter profit. Hanway took home $12.2 million in 2009. He started his golden years last week with a retirement bonus worth $73 million.

But last week’s biggest stunner may have been the revelation that, back in 2008, the New York Federal Reserve Bank directed AIG, the tottering insurance company, “to withhold details from the public about the bailed-out insurer’s payments to banks during the depths of the financial crisis.”

What details? Banks like Goldman Sachs had “insured” their risky investments by cutting credit default swap deals with AIG. Goldman stood to lose $13 billion if AIG couldn’t pay off those swaps. But AIG did pay off every last one, at 100 cents on the dollar, by using bailout tax dollars.

In essence, the U.S. Treasury was laundering tax dollars to Goldman and other big banks via AIG, and the New York Fed — by instructing AIG not to reveal those outlays — was trying to cover up all the laundering.

The New York Fed’s top official during all this? Timothy Geithner, the current Treasury secretary.  

At Treasury, Geithner has continued to keep Wall Street’s most eminent most comfortable. Last year, he pushed back repeatedly against any attempt by Congress to place meaningful bailout strings on banker pay. And the bailout “pay czar” he oversees, Ken Feinberg, has essentially decided that if bankers get paid millions in stock instead of cash, that counts as reform.

More serious efforts at reform, in the meantime, remain bottled up in congressional gridlock. The occasional tough-minded pay-limit measures that have passed the House have all lost steam in the Senate. The White House, amid this inaction, has come across as out of touch — with ordinary Americans.

President Obama’s “kid-gloves treatment of the bankers,” as economist Paul Krugman observed last week, has placed “Democrats on the wrong side” of the “populist rage” now building throughout the country.

“If congressional Democrats don’t take a tough line with the banks in the months ahead,” Krugman adds, “they will pay a big price in November.”

But the President doesn’t have to wait on Congress. His federal agencies, right now, have the authority and the capacity to start clamping down on executive pay excess, even without congressional action.

At the FDIC, the federal agency that insures bank deposits, officials have started making some tentative steps in that direction. All banks pay fees to the FDIC, and banks that engage in risky practices that make bank failure more likely pay higher fees.

Up until now, the FDIC has never considered excessive bank executive compensation a practice that endangers bank stability. But the FDIC, according to news reports, may be about to change course and define pay excess as a reckless practice.

The IRS, argues an analysis forthcoming in the Yale Law Journal, could take a considerably more sweeping step against that pay excess — just by treating publicly traded companies “the same as their privately held counterparts.”

The U.S. tax code, the analysis author Aaron Zelinsky points out, currently lets businesses deduct off their taxes “a reasonable allowance for salaries or other compensation.” But the IRS has essentially only applied this reasonableness standard to privately held companies.

At such companies, the assumption goes, unscrupulous executives could pay themselves fortunes and avoid corporate taxes by deducting those fortunes on their corporate tax returns.

At publicly traded companies, the IRS assumes, boards of directors accountable to shareholders serve as a check against this sort of unscrupulous executive behavior. In real life, of course, corporate boards don’t check. They rubberstamp.

IRS blindness to this reality lets excessive executive pay grow and fester.

“Small fry at privately held companies, earning relatively small sums of money, can lose the corporate deductions for excessive executive compensation,” points out Zelinsky, “while CEOs of much larger corporations face no similar rules or penalties.”

By simply ending this double-standard, by beginning to subject big-time executive pay to a “reasonableness” test, the IRS could deny major corporations tax deductions for over-the-top executive pay.

Any IRS ruling that a corporation’s executive pay has become unreasonably excessive would also subject corporations to big-time negative publicity — and give dissident shareholders valuable ammunition for firing away at pay excess.

The White House could make all this happen, without any action needed from Congress. The White House, in short, has the wherewithal for attacking the windfalls at the top that so anger average-income Americans. Does the White House have the will? That may prove this year’s important political question.

New Wisdom on Wealth

Moshe Adler, Bringing overpaid executives to heel, Los Angeles Times, January 4, 2010. A Columbia University economist makes ther case for legislating a maximum ratio between a company’s highest executive pay and the lowest worker’s wage.

Richard Alcock, We need a rich guinea pig, Guardian, January 7, 2010. A delightful exploration of “why we pay less and less to the less well paid, expecting them to work more and more, while we pay more and more to the best paid.”

Barbara Bartlein, Addiction to greed: Why the wealthy still steal from the till, WalletPop, January 8, 2010. What the $24 million embezzlement — by the executive VP at a Midwest high-tech company — tells us about affluence as a life’s goal.

In Review

A Thermodynamic Take on Executive Pay

Venkat Venkatasubramanian, What is Fair Pay for Executives? An Information Theoretic Analysis of Wage Distributions. Published in Entropy, an international scientific journal, November 2009.

We’ve known the basic facts about CEO pay for quite some time now. U.S. top executives today take home, on average, over 300 times what their workers earn. Until the 1980s, these execs seldom made over 40 times worker pay.

But what should CEOs make? In an ideal world, exactly how much pay should go to the top execs of major enterprises that employ many thousands of people?

Economists, by and large, don’t bother with questions like these. They assume the “free market” will work out an appropriate answer.

But the “free market,” at the executive level, isn’t working too well. Corporate boards determine executive pay, not the “laws” of supply and demand. And these boards, as Purdue University chemical engineer Venkat Venkatasubramanian points out in this provocative new analysis of executive compensation, have no “rational quantitative framework for evaluating a CEO’s value.”

What’s a chemical engineer doing writing about CEO pay?

“The same concepts and mathematics used to solve problems in statistical thermodynamics and information theory,” Venkatasubramanian explains, “can be applied to economic issues, such as the determination of fair CEO salaries.”

His new paper does that applying. Or, to be more specific, this Purdue engineer applies to executive pay “the Principle of Maximum Entropy,” along the way drawing on concepts from thermodynamics and statistical mechanics, winding up with a framework he calls “statistical teleodynamics.”

If you can follow all that, you’ll really enjoy this new paper. But even if you can’t, this contribution to the scientific journal Entropy has plenty of insights to offer. Venkatasubramanian mixes equations with expositions you don’t have to be an engineer or scientist to follow.

Venkatasubramanian gets his logic train rolling by asking us to imagine two extreme pay scenarios. In one, everyone in an enterprise — from the cleaning crew to the chief executive — gets the exact same reward. In the other, the bulk of the rewards go to the CEO and everyone else gets paid an negligible amount.

Each scenario makes an unsustainable assumption, the first that everyone is contributing in absolutely equal value to enterprise success, the second that only the CEO is contributing real value. No enterprise could long survive with either scenario. The disenchanted would abandon ship “in droves.”

The optimum compensation configuration, Venkatasubramanian observes, must lie “somewhere in between these two extremes.” But where? What would be the “maximally fair assessment of relative value”?

His eventual answer: Fair total compensation for an average S&P 500 CEO should ideally be in the range of eight to sixteen times the lowest employee take-home.

In 2008, the actual pay gap between workers at the bottom and the top 500 CEOs averaged 50 times more than this ideal. Venkatasubramanian also looked at a sampling of 35 of that year’s 50 highest-paid CEOs. They took home 129 times more than his no more than sixteen-to-one ideal ratio.

Venkatasubramanian feels his quantitative framework could be a useful jumping-off point for designing tax policy and corporate governance guidelines.  But how practical would his framework actually be? This practical: Executive pay in Japan and other successful industrial nations already fits within his guideposts — and U.S. executive pay, back in the 1960s, came close to fitting in, too.

In other words, as Venkatasubramanian points out, America’s “executive pay excesses appear to be a recent phenomenon.”

And a dangerous one, too. Markets only work in an orderly fashion, this Purdue analyst relates, when “participants feel they have received a maximally fair deal given the constraints.” Our economic systems, he adds, “work best when they have orderly markets.”

“Why then,” his paper asks, “would anyone want to maximize disorder?”